The Harvard Project on Climate Agreements March 2014 Discussion Paper 14-64 Carbon Tariffs Revisited Christoph Böhringer University of Oldenburg Germany André Müller ECOPLAN Switzerland Jan Schneider University of Oldenburg Germany Email: [email protected] Website: www.belfercenter.org/climate Carbon Tariffs Revisited Christoph Böhringer University of Oldenburg Germany André Müller ECOPLAN Switzerland Jan Schneider University of Oldenburg Germany Prepared for The Harvard Project on Climate Agreements THE HARVARD PROJECT ON CLIMATE AGREEMENTS The goal of the Harvard Project on Climate Agreements is to help identify and advance scientifically sound, economically rational, and politically pragmatic public policy options for addressing global climate change. Drawing upon leading thinkers in Argentina, Australia, China, Europe, India, Japan, and the United States, the Project conducts research on policy architecture, key design elements, and institutional dimensions of domestic climate policy and a post-2015 international climate policy regime. The Project is directed by Robert N. Stavins, Albert Pratt Professor of Business and Government, Harvard Kennedy School. For more information, see the Project’s website: http://belfercenter.hks.harvard.edu/climate Acknowledgements The Harvard Project on Climate Agreements would like to thank the Harvard University Center for the Environment for its generous support of the current series of publications. The Harvard Project receives additional support from Christopher P. Kaneb (Harvard AB 1990); the James M. and Cathleen D. Stone Foundation; and ClimateWorks Foundation. The Project is very grateful to the Doris Duke Charitable Foundation, which provided major funding during the period July 2007–December 2010. The Project receives ongoing support from the Belfer Center for Science and International Affairs at the Harvard Kennedy School. The closely affiliated, University-wide Harvard Environmental Economics Program receives additional support from the Enel Endowment for Environmental Economics at Harvard University, the Enel Foundation, the Alfred P. Sloan Foundation, the Mossavar-Rahmani Center for Business and Government at the Harvard Kennedy School, Bank of America, BP, Chevron Services Company, Duke Energy Corporation, and Shell. Citation Information Böhringer, Christoph, André Müller, and Jan Schneider. “Carbon Tariffs Revisited.” Discussion Paper 2014-64. Cambridge, Mass.: Harvard Project on Climate Agreements, March 2014. The views expressed in the Harvard Project on Climate Agreements Discussion Paper Series are those of the author(s) and do not necessarily reflect those of the Harvard Kennedy School or of Harvard University. Discussion Papers have not undergone formal review and approval. Such papers are included in this series to elicit feedback and to encourage debate on important public policy challenges. Copyright belongs to the author(s). Papers may be downloaded for personal use only. CARBON TARIFFS REVISITED Christoph Böhringer, University of Oldenburg, [email protected] André Müller, ECOPLAN, [email protected] Jan Schneider, University of Oldenburg, [email protected] Abstract Concerns about adverse impacts on domestic energy-intensive and trade-exposed (EITE) industries are at the fore of the political debate about unilateral climate policies. Tariffs on the carbon embodied in imported goods from countries without emission pricing appeal as a measure to reduce carbon leakage and protect domestic EITE industries. We show that the introduction of carbon tariffs can do more harm than good to domestic EITE industries. Two determinants drive the sign and magnitude of EITE impacts. Firstly, the composition of embodied emissions in goods: if a large share of embodied carbon is imported in intermediate inputs, industries might suffer from carbon tariffs. Secondly, the share of domestic output that is supplied to the export market: while carbon tariffs level the playing field on domestic markets, they increase the cost-disadvantage vis-à-vis competitors from abroad in foreign markets. Keywords: carbon tariffs, unilateral climate policy, multi-region input-output analysis, CGE JEL classifications: Q58, D57, D58 1. Introduction Concerns on the competitiveness of domestic emission-intensive and trade-exposed (EITE) industries are at the fore of the unilateral climate policy debate. Industries where emission-intensive inputs represent a significant share of direct and indirect costs will face negative production and employment effects from unilateral emission pricing. These adverse impacts will be more accentuated for emission- intensive industries which are trade-exposed since they do not only face higher cost vis-à-vis less emission- intensive production sectors at home but also a loss in comparative advantage against competitors abroad. Prima facie, the losses of EITE industries in competitiveness at the national and international level could be viewed as the logical outcome of structural change towards cleaner production and consumption patterns. At second glance, however, requests for EITE-specific protective measures can be rooted in more general economic efficiency considerations. The reasoning behind is the global nature of the carbon externality. While unilateral carbon pricing will decrease domestic production and emissions of carbon- intensive tradable goods, this may be counteracted by increased production of such goods abroad. Given that only world-wide CO2 emissions matter for climate change, such carbon leakage can seriously hamper the cost-effectiveness of unilateral emission regulation (see e.g. Hoel, 1991; or Felder and Rutherford, 1993). 1 Measures to attenuate the loss in competitiveness of domestic EITE industries therefore bear some efficiency rationale and cannot be simply disguised as blunt lobby policy by interest groups. Principal among anti-leakage measures are carbon tariffs where emissions embodied in imports from non-regulating regions are taxed at the emission price of the regulating region. Carbon tariffs are appealing in various respects. Economists appraise them as a second-best instrument to reduce leakage and improve global cost-effectiveness of unilateral emission regulation (Markusen, 1975; Hoel, 1991).1 Environmentalists embrace them as a means to capture the carbon footprint of imported products. Stakeholders of EITE industries welcome carbon tariffs as a corrective measure which levels the playing field in international trade of emission-intensive goods. The concordant main findings of previous quantitative studies (see e.g. Caron, 2012; Fischer and Fox, 2012; Balistreri and Rutherford, 2012) are that carbon tariffs reduce carbon leakage, typically increase global cost-effectiveness of unilateral action and – last but not least – attenuate adverse production impacts of unilateral emission pricing for domestic EITE industries.2 In this paper we focus on the economic implications of carbon tariffs for EITE industries. Contrary to previous findings, we show that carbon tariffs can worsen rather than ameliorate adverse impacts for unilaterally regulated EITE industries. The key impact drivers are the amount and composition of embodied emissions in EITE production (consisting of direct emissions from fossil fuel inputs, indirect emissions embodied in domestically produced intermediate inputs, and indirect emissions embodied in imported intermediate inputs) and the share of EITE production that is supplied to the export market. If the carbon embodied in an EITE good stems predominantly from imported inputs, then this industry can rather suffer than benefit from the imposition of carbon tariffs. Likewise, industries exporting larger shares of their output suffer more, since carbon tariffs level the playing field only in domestic markets but lead to a further cost- disadvantage in foreign markets. Export-oriented EITE industries that are relatively clean in terms of direct emissions but rather dirty in terms of the imported carbon run the risk to shoot themselves in the foot if they lobby for carbon tariffs. We draw our conclusions from combined multi-region input-output (MRIO) and computable general equilibrium (CGE) analyses. In our numerical simulations we focus on Switzerland and the United States of America as prime examples of how carbon tariffs can affect the performance of EITE industries in opposing ways. While we find that carbon tariffs reduce the adverse EITE production impacts of unilateral emission pricing in the case of the US, they exacerbate the negative EITE production effects in the case of Switzerland. The remainder of this paper is organized as follows. In Section 2 we describe our benchmark data, provide non-technical summaries of our MRIO and CGE models and lay out our policy scenarios. In Section 3 we present MRIO estimates on embodied carbon and discuss differences in the output supply of EITE 1 In theory, full border carbon adjustment also includes rebating of emission charges levied on exports to non-regulating countries. However, export rebates may constitute a subsidy under the WTO’s Agreement on Subsidies and Countervailing Measures (Cosbey et al., 2012) and therefore are generally omitted in policy proposals. 2 Böhringer et al. (2012a) provide a summary of a model cross-comparison study on the economic impacts of carbon tariffs. 2 industries between Switzerland and the US. In Section 4 we interpret CGE simulation results on the economic impacts of carbon tariffs. In section 5 we conclude.